Everything seems to be going right for Tesla (NASDAQ:TSLA) recently -- and investors are responding by bidding up the stock. Shares are have risen about 74% over the past six months, recouping a decline from during the first half of the year and hitting a new all-time high. Bullishness for the stock gives Tesla an impressive $70 billion market capitalization, easily exceeding both General Motors and Ford, which have market caps of $54 billion and $38 billion, respectively.
Given the stock's huge run-up, it's a good time for investors to stop and consider whether Tesla shares should be bought, held, or sold at this level. While vehicle deliveries are soaring on a year-over-year basis and quarterly profitability is becoming more regular, this doesn't automatically mean investors should continue piling on this stock. Valuation matters.
What should investors do?
2019 is proving to be a breakout year for Tesla's vehicle sales growth and profitability. Before the year started, Tesla's free cash flow improved from negative-$4.1 billion in 2017 to negative-$222 million in 2018 as the electric-car maker started seeing financial benefits from cost-cutting initiatives and higher-volume Model 3 production. Now Tesla has swung to positive free cash flow as the automaker's big investments to ramp-up Model 3 faded into the rearview mirror and the company benefited from greater efficiencies of even higher Model 3 production volume. Tesla has been free cash flow positive for two quarters in a row and management is forecasting another free cash flow positive quarter in Q4.
"We continue to believe our business has grown to the point of being self-funding," said management in the company's third-quarter update.
Tesla's electric cars are catching the attention of consumers. Vehicle deliveries are soaring, with trailing-12-month vehicle deliveries up 88% year over year, driven by Model 3. Trailing-12-month deliveries of the important vehicle, which is Tesla's lowest-cost electric car yet, have more than tripled year over year.
Meanwhile, Tesla is making progress on its factory in Shanghai, where it is making Model 3 vehicles for customers in China. The company said in its third-quarter update that it is working on meeting government requirements in the country before ramping up production.
Tesla management is excited about the Model 3's potential in the market. "With Model 3 priced on par with gasoline-powered mid-sized sedans (even before gas savings and other benefits), we believe China could become the biggest market for Model 3," Tesla said in its third-quarter update.
Looking ahead, the electric-car maker is also expecting to begin production of its Model Y crossover early next year.
A speculative valuation
Despite Tesla's great progress in production efficiencies, higher-volume deliveries, and outlook for Tesla's China-made Model 3 and its upcoming Model Y, investors should keep in mind that the stock's valuation largely prices in more astounding growth.
Tesla currently trades at 3 times sales and has only raked in $872 million in trailing-12-month free cash flow. The automaker's $70 billion market capitalization, therefore, prices in more strong growth for years to come.
While investors may want to think twice before selling Tesla stock amid such impressive execution, they should also look for a greater margin of safety before buying the stock at this level. It's fine for a stock to be priced for expected growth. But investors may want to either wait for a pullback in the stock price or for Tesla to deliver more regular and meaningful profits before they consider buying shares.
Put more bluntly, Tesla stock looks like a "hold" at this level.